Upfront let’s be honest. Comparing one to the other is not completely fair, given the fact that both are completely different products and target different needs in a portfolio. While PPF is a great investment for every single investor, so is equity.
So why are we comparing the two?
Here’s why.
The Public Provident Fund, or PPF, and an equity linked savings plan, or ELSS, are both eligible for a deduction under Section 80C of the Income Tax Act. So the amount invested in either is eligible for a deduction up to Rs 1.50 lakh. (Frankly, that’s pretty much where their similarity ends). As a result, both investments score high on the tax front.
In the case of PPF, the interest earned is tax free and the entire amount on maturity (principal + interest accumulated) is also tax free. It is a win-win situation all the way. Or in technical terms, EEE –indicating that it is exempt from tax at three stages. (Read: How to position PPF in your portfolio).
Where ELSS is concerned, the money has to stay invested for a minimum of 36 months. Which means that long-term capital gains is zero. So no tax here too.
Having said that, would it be logical to conclude that it makes no difference which one to opt for?
Not at all.
ELSS does have a benefit in the sense of its lock-in period being much shorter; three years is definitely more attractive than the 15 of PPF. So on the liquidity front it scores. But the stark difference lies in the risk of each product.
On the face of it, if one looks at the risk of losing one’s capital, ELSS stands nowhere close to PPF. After all stocks have a much higher level of risk in that you could lose your money. This does not even arise in the case of PPF which is a fixed return investment backed by the government. You are guaranteed your capital back as well as a pre-determined return. No such guarantees in the case of ELSS.
However, if one looks at the tax-saving category of mutual funds, the average annualized returns over past 15 years (17.13%), 10 years (9.52%), 5 years (10.24%) and 3 years (14.39%), investors would not be unhappy. Yes, in the short term the returns can be devastating (the 1-year return is -14%), but invest in a sound ELSS for the long term and you will be rewarded. (Read: How to pick a tax-saving fund).
The returns of PPF have actually declined over time: 12% to 11% to 9.5% to 9% and 8%. Over the past few years, it has hovered between 8.6% and 8.8%.
When investing, investors must also consider shortfall risk. This is the risk that an investment’s actual return will not be sufficient to generate the money needed to meet one’s investment goals. That is why equity is so crucial in an investor’s portfolio because good equity investments over the long term do provide returns which outpace inflation. According to Inflation.edu, the average CPI in India over the past 10 years has fluctuated from 5.79% (2006) to 12.11% (2010).
If investors invested all their money in fixed return investments like PPF, there is a very high probability that they would certainly not save sufficiently for retirement, unless they were earning obscene amounts of money. To create wealth, you need to be invested in equity.
So if your overall equity exposure is less than desired, considering your risk profile and age, then you could look at ELSS. If your portfolio does have a considerable exposure to equity, then you could just go with PPF.
The conclusion: As we mentioned in Be holistic in your tax planning, make your final decision in conjunction with your entire portfolio.
This article is part of a series on tax planning: